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BECAUSE 2008 ALREADY SUFFERS A SURFEIT of gloom, let's begin with a little good news: Wall Street's top strategists believe -- or hope -- that the U.S. stock market has already absorbed the worst of the selling pressure this year, and will start to recover in 2009.

That's not to say there won't be violent rallies and sharp pullbacks along the way. An urgent scramble to dump risky assets and hoard capital this year triggered a crisis of credit -- and confidence -- that wiped out more than half of the stock market's value. And while stocks quickly rebounded 18% from their late-November low, the dozen strategists and chief investment officers surveyed by Barron'sexpect the Standard & Poor's 500 index to finish 2009 near an average of 1045, or 18% above today's level of 888.

Such a forecast may not seem very modest at first -- until you consider strategists' vocationally bullish bent, how this volatile market can easily cover 18% in mere days, and all those statistics promising massive gains a year after stocks first slip into -- and presumably bounce out of -- a bear market. In fact, a majority of the surveyed strategists have pinned their 2009 year-end targets within a narrow 50 points of the 1,000 mark as though there's safety in numbers.

The source of their circumspection: the uncertain economy. Nearly everyone expects the U.S. economy to worsen as companies cut costs and lay off workers (on top of the 1.25 million jobs already eliminated from September to November), and as economists pencil in gross domestic product declines of 4% or more for the fourth quarter of 2008 and early 2009. And while the consensus hopes for a second-half rehabilitation, no one knows when a lasting recovery will take hold. Indeed, 10 of the 12 firms surveyed see the U.S. economy contracting in 2009.

So why should stocks rise in the face of such ambiguity? For a start, the strategists hope that a stock market that has already fallen 52% from its 2007 peak to its Nov. 20 low has discounted much of the deterioration still to come. With more than 37% of mutual-fund assets recently parked in money-market funds, the highest level since 1991, there's ample cash for bargain hunting should stocks dip below a certain threshold. Hopes run high that cheaper energy costs will support consumer spending, and -- most important -- that the deep freeze in the credit markets triggered by Lehman Brothers' collapse will continue to thaw. And everyone is counting on the government's aggressive policies to help stop the rot.

"The size of global policy response to stabilize both the financial system and the growth outlook is virtually unprecedented," says Morgan Stanley chief global equity strategist Abhijit Chakrabortti. "It does not appear likely to us that equity markets will fall substantially from here, given growth expectations have been substantially lowered, growth data are depressed and there is a high level of skepticism surrounding the ability of policy-makers to salvage the financial system and stabilize growth."

A year earlier, forecasters made the mistake of placing too much faith in the Fed -- back then, they believed the Federal Reserve's interest rate cuts and thriving foreign economies could help the U.S. stave off a recession. This time around, their trust may be more justified: at least the government is no longer in denial about the economic threat, and fighting deflation has become the urgent priority for governments around the world. Just last week, the Fed cut benchmark rates below a historic 0.25% and promised a vast array of lending programs to consumers and businesses.

AT THE SAME TIME, investor expectations have been quashed -- the bar is set low when today's yardstick is the Great Depression. Witness the lunge for safety and near-zero yields on short-term Treasuries. "People are practically paying the government to hold their money -- if that's not a sign of negative sentiment, I don't know what is," says Jason Trennert of Strategas Research Partners.

No one thinks wild swings will subside quickly from record 5%-a-day moves in October, but the downward plunges have at least been replaced by volatility of the sideways variety. "The market can rally fiercely and then pull back some," says Citigroup's chief investment strategist Tobias Levkovich. Over the eight years after the 1932 bottom, there were at least five rallies that averaged 93%. The 1974 bear-market bottom spawned no fewer than six rallies over the next eight years averaging 32.5%. The surges, however, were followed by retreats, and Levkovich sees the choppy S&P 500 ending 2009 at 1,000.

IF THESE STRATEGISTS ARE RIGHT, the 39% gain from the Nov. 20 low of 752 to 1045 might mark the tentative start of a new bull market -- or a big bounce within an extended bear market. Even those who expect the S&P 500 to hold its Nov. 20 low see that threshold being tested in 2009 -- not immediately, since fresh allocations toward decimated stocks will provide a momentary lift. But buyers' resolve will be tested as early as February, when companies reporting messy fourth-quarter earnings offer a peek at the damage they've sustained.

Also, "I think a lot of bad decisions might have been made in the record volatility of this year's second half, and odds are there could be another surprise," warns Thomas Lee of JPMorgan. Potential threats that might rattle the market include a collapse of, say, a big U.S. industrial company or a foreign bellwether, or debt defaults by a sovereign power. Lee sees a range-bound first half, before a possible second-quarter test spawns a constructive second half. All through 2009, Wall Street expects the Fed to keep borrowing costs at extremely hospitable levels to goose spending, and at least nine strategists (or their economists) see benchmark rates kept below 1% even a year from today.

The flight to quality that drove 10-year Treasuries' yield down toward 2% last week also smacks of "a crowded trade and feels a little overdone," says Alison Deans, Neuberger Berman's chief investment officer. The firm's portfolio managers increasingly are scouring investment-grade corporate debt -- sporting attractive yields above 7% -- to park their money while browsing for stocks. In fact, 10 of the 12 strategists expect Treasuries to back off next year and for the 10-year yield to reverse its slide; the holdouts are JPMorgan, whose bond strategists see the benchmark yield finishing 2009 at 1.65%, and Merrill Lynch. (For Barron's bond-market outlook, see Current Yield.)

Anyone looking for change in 2009 will not be disappointed. As America weans itself off debt, and as the government begins to own banks, insurers or even automakers, a "tectonic shift occurs with the transfer of leverage from the private to the public sector," says Christopher Hyzy, chief investment officer of U.S. Trust, Bank of America's private wealth-management unit. The world's gross imbalances will begin to moderate. For example, developing Asia will see savings decline and spending rise, while the West, anxious to mend its balance sheets, will save more and spend less.

Top strategists and chief investment officers on whether the market has hit bottom yet. (Dec. 20)

The clearest consensus about this period of rebalance and repair is for stocks to suffer limited downside risk, but also capped upside gains. But when pressed to pick which one of these two notions they feel more confident about, the strategists become quite evenly divided.

BULLS WHO THINK THIS TIGHTLY wound market is more likely to surprise to the upside point out how cheap stocks have become. "Bottom-up" predictions by Street analysts for the S&P 500 to earn $78 a share next year seem na&iuml;ve, and surely will be slashed toward less-deluded "top-down" estimates from strategists who have factored in the weakening economy and who peg profits at $60.20.

David Kostin, Goldman Sachs' chief investment strategist, expects operating earnings to slip 33% this year to $55 a share, then fall another 5% next year to $53 before rebounding in 2010 to $69. While he steers clients toward more defensive companies with strong balance sheets and reliable dividend growth, he says that an overall market trading at 1.7 times book value -- half the 10-year average of 3.4 times -- is a sign "the equity market is undervalued from a long-term perspective."

Studying how far multiples shrank during previous swoons, Kostin pegs the trough for the S&P 500 at 850 if this proves to be an average bear market. But if this bear market plays out to a worst-case scenario, the bottom could be a lot lower, at about 630.

Valuation multiples expanded relentlessly in the 1980s and 1990s as long-term interest rates fell. Stocks won't enjoy the same lift today, with the 10-year yield already near 2%. Still, price-to-earnings multiples "are well below where they should be, given where interest rates are and where inflation is," argues Larry Adam of Deutsche Bank Private Wealth Management. He thinks multiples can expand as investors' appetite for risk returns.

"The S&P 500 also is at its most broadly diversified in at least a decade," Adam adds. Technology hogged 30% of the benchmark's weight in 1999, while financials took up more than 22% in 2006, but today the most prominent segments -- technology, consumer staples -- represent no more than 15% of the increasingly balanced market.

James Paulsen of Wells Capital Management says the U.S. was dealt a below-the-belt blow from which it can bounce back. "The one policy that had been tremendously effective was the well-orchestrated fear-mongering campaign" waged by the Treasury and the Fed to persuade Congress to pass a $700 billion bailout bill, Paulsen says.

The bad news: the resulting crisis of confidence frightened perfectly healthy corporations and consumers into suspending economic activity. "But the good news also is that it is a crisis of confidence," Paulsen says. "Just as we're surprised by the crisis' depth and severity going in, we might be surprised by how sharp the rebound can be going out."

Concerns about the collapse of consumer spending -- the engine that drives the U.S. economy -- also may have been exaggerated. "Credit won't grow at the rate we're accustomed to, but there's still pent-up demand from deferred purchases," says Jerry Webman, Oppenheimer Funds' senior investment officer. And let's not forget the boost that comes from $40 oil.

SO WHAT'S HOLDING STOCKS BACK? "If you have to point to one constant in the market, it is uncertainty," says Hyzy. More cautious strategists think the S&P 500 will struggle to sustain rallies above 1050, since investors will be asked to pay more than 15 times for per-share earnings of $70 or more.

Many strategists, of course, hope housing demand will recover as mortgage rates fall and as the new administration pushes consumer-friendlier reform. Unemployment might not peak until late-2009 near 9%, but it is a lagging indicator, since employers typically hold off new hires until they are convinced things are looking up. Still, weaker operating leverage, compressed profit margins, a stronger dollar and anemic foreign growth could all cap rallies.

Among the more prescient calls from last year's forecast was Merrill Lynch's prediction of "the first consumer-led recession since 1991," even if the firm, too, underestimated the severity of this year's selloff. While others were anticipating a profit rebound, Merrill also was among the first to forecast weaker profits in 2009 -- a view that has since become consensus.

Today, the firm still hews to its defensive crouch, although chief investment strategist Richard Bernstein reckons "2009 is likely to be better than 2008 for investors." Among other things, he preaches patience in the rush to pick a market bottom, "since the opportunity cost is low and there's a stiff penalty for being early and wrong." Merrill economist David Rosenberg thinks fiscal stimulus can help "cushion the blow but will not reverse the business cycle." Spirited consumption by baby boomers kept recent recessions short and mild. But now, "the average boomer is in his 50s and after two decades of spending, the boomer is done."

With this decade's booms -- in commodities, real estate, hedge funds and private equity -- all swelled by cheap money, Bernstein says the violent market shakeup and bursting of the credit bubble will pave the way for new market leaders. Defensive segments like consumer staples and health care may prove to be more than a temporary shelter, and could outperform even over the longer run.

Asked what it'll take before he turns more bullish, Rosenberg flags three markers that could signal a sustainable economic expansion: the rise of the U.S. personal savings rate to 8% from 2%; a decline in the glut of unsold new homes, currently at 11 months' supply, to about eight months' worth; and for the percentage of household after-tax income spent servicing debt to fall from more than 13% to about 10.5%.

Where lurk the potential shocks? For many strategists, the happiest surprise is if the financial system gets fixed swiftly. That could drive the S&P 500 to 1190, and Chakrabortti pegs the chances of that at 20%.

By early next year, the losses suffered by banks and brokerages also will pass the $1 trillion mark, and "odds are good that markdowns and provisioning have already peaked," says Chakrabortti, who warned more than a year ago that downturns led by housing -- the world's slowest-moving assets -- tend to be prolonged. Improving value for deeply discounted loans might even trigger "write-backs," where financial firms that haven't dumped their debt get to bump up the value of their loan portfolios.

On the other hand, policy failure and dislocated financial markets could send the S&P 500 to 400, the odds of which Chakrabortti pegs at 25%. "Another potential downside surprise is if Asian or emerging-market consumption falls sharply -- I don't think that has been discounted by the market."

Meanwhile, inflation -- so feared just a few months ago -- goes virtually unremarked these days, even though the government bluntly promises it will print as much money as necessary to keep the financial systems functioning. "The trade of 2009 will be to figure out when to stop playing deflation and begin playing inflation again," Trennert says.

AGAINST THIS UNCERTAINTY, model portfolios must walk a delicate balance between guarded and bold: The three sectors favored by BlackRock's global chief investment officer Robert Doll are health care, with its strong cash flow and its defensive stance; technology, which straddles the divide between stability and cyclicality; and energy, which is the most economically sensitive.

Forcing borrowing rates down to zero will need time to work. In this climate, Hyzy prefers "the top of the capital structure" -- essentially more secure senior debt -- and keeping an eye on small- to mid-cap stocks that could outperform if the Obama administration manages to stimulate job creation. He also emphasizes infrastructure and defense stocks. "There is a propensity for violence during tough times, and conflicts can arise as the global economic downturn picks up steam," he says. "We must be prepared for that."

While the market has flocked toward quality -- strong balance sheet, robust cash flow, predictable profits -- investors should keep an eye out for improving credit spreads and a return of risk appetite. "At some point, the argument for quality could become long in the tooth, and lower quality will do just fine -- thank you very much," Doll says. When that happens, investors might shift some money from big pharmaceuticals toward HMOs within health care, from software toward select chip makers, and from big integrated oil companies toward explorers and refiners. Ditto a shift from the currently popular domestic focus back toward multinationals with international clout.

No surprise: health care is the new year's most crowded trade, with the sector beloved by 10 of 12 strategists.

Curiously, technology was favored by five out of the six buy-side CIOs, but not one sell-side strategist. Deutsche's Adam, for one, likes tech companies' cash stash and self-sufficiency from the debt market. Inventory is disciplined after the bloated bubble years, and technology improves productivity of companies operating with leaner staff. Our next president, Barack Obama, is a tech-savvy broadband geek, and even his health care reform includes tech-reliant proposals like the modernizing of medical records.

The knock on the sector, however, is how companies might find it easier to slash capital spending than lay off workers. Credit-market indicators suggest that payrolls will shrink another 3% by the summer, but capital spending could be cut 15%, says Citi's Levkovich. "Companies that sell to consumers could suffer, but companies that sell to other companies will be worse off," he says. His picks include retailers, where "expectations are already extraordinarily poor."

A chasm also has opened up in financials, which is favored by four sell-side strategists. "America's private debt -- the aggregate value of household and corporate debt -- is trading at 70 cents on the dollar, and that's not the right price," says JPMorgan's Lee, who expects this fear-driven discount to narrow after the rush to delever. Tightening credit spreads and a steeper yield curve also should help financial firms.

ODDLY ENOUGH, NOT ONE of the surveyed buy-side managers is ready to warm up to financials. Like tech stocks earlier this decade and energy stocks in the early 1980s, financial stocks need a lot more time to recover from the pricking of the credit bubble. "More capacity needs to be taken out, which means more bad debt, write-offs and consolidation," Doll says. "Policy is an ameliorating factor and it is targeted at financials, the sickest part of the market. But if it works, it will benefit the whole economy." In other words: why risk betting on financials?

Meanwhile, the sectors that led the most recent bull market have become its new pariahs: Energy is recommended by just two strategists, and materials by only one. "While demand for commodities will be hurt in a global recession, we have done virtually nothing to solve our oil dependence," says Doll, who sees energy stocks bouncing should the economy return to any semblance of normalcy. Crude oil has also fallen more than 70% to below $40 a barrel, and Doll sees the $40 level "as a flashpoint below which oil-producing countries will curtail supply." (OPEC, in fact, voted last week to reduce supply.)

In contrast, four strategists suggest avoiding energy, four are dissing materials and five suggest steering clear of industrials. Quite remarkably, 12 of these 13 negative calls against these commodity-driven sectors are from the sell-side. Materials and industrial companies, for instance, are famously capital-intensive. They suffer big depreciation expenses that erode earnings and pressure margins, and commodity prices are still falling. "The bar is set very high for companies that led the previous bull market," Lee says, "and it's rare for old leaders to re-assert themselves."

For that matter, even the vanquished bull market itself will need a little help -- and a little hope -- to reassert itself in the year ahead.